Dell wrestles with its accounting

Analysis: Bookkeeping probes suggest more risk ahead

MattAndrejczak

SAN FRANCISCO (MarketWatch) -- When Dell Inc. announced in mid-August it was being investigated for accounting problems by federal securities regulators, investors mostly shrugged it off.

The stock is up 20% over the past two months as Wall Street has placed bets that the struggling personal computer maker is turning its business around -- and that the probe would turn up no skeletons in Dell's accounting closet.

But this week, Dell shareholders may now be asking themselves if there's something to be scared of after all.

This week, Dell
DELL
abruptly announced it was delaying releasing its third-quarter results. Worse yet, it said the Securities and Exchange Commission had upgraded its investigation to formal status.

The latest disclosures suggest "management may not fully have their arms around the situation yet," said Nick Rodelli, senior analyst at the Center for Financial Research and Analysis, a forensic accounting shop in Rockville, Md.

In an unusual wrinkle, federal prosecutors stepped into this case even before the SEC made its investigation formal. On Sept. 11, Dell said the U.S. Attorney's Office in the Southern District of New York has subpoenaed documents related to the company's financial reporting from 2002 to the present.

Since criminal accounting cases are much tougher to prosecute in court than civil ones, the Feds typically step in after the SEC has done a fair amount of leg work, according to former enforcement officials at the SEC and the Justice Department.

In addition to their subpoena power, federal attorneys can compel executives and managers to testify in formal depositions.

The U.S. Attorney's Office may be involved at this point to ensure Dell doesn't obstruct justice or destroy documents, said John Carney, partner at the law firm of Baker Hostetler and former attorney at the SEC and Justice Department.

The latest accounting-related revelations couldn't come at a worse time for Round Rock, Texas-based Dell. As of Sept. 30, Dell lost its status as the world's No. 1 PC-provider to rival Hewlett-Packard Co., according to Gartner Inc., a technology research firm.

And some shareholders have voiced displeasure with Dell Chief Executive Kevin Rollins, who succeeded Michael Dell in March 2004. Since Rollins took over, Dell has struggled with slower sales growth, a faltering stock price, and stiffer competition.

For the most part, Dell has offered investors few clues as to what's making it nervous about its accounting.

By postponing its earnings release, Dell officials may be playing safe, knowing that the attorneys at the SEC and U.S. Attorney's Office in New York are looking over their shoulder.

Working under new corporate disclosure laws Congress passed in 2002, "accountants are much more careful these days," Carney added. "The audit firm is not going to sign along the dotted line unless they are more than 100% certain the company has got it right," he added. "If they have suspicions, their risk management team will hold things up until they have a handle on it."

On top of that, Dell doesn't plan to hold a conference call when it releases earnings by month's end, further suggesting some unease among the company's board and its lawyers about the depth of the company's accounting problems, attorneys and forensic accounts said.

Dell has made it clear it's wrestling with the way in which it accounts for items on its balance sheet, such as reserves and accruals. It said it is cooperating with the SEC's investigation.

Warranties are one of the larger accruals on the company's balance sheet, according to Jeremy Perler, senior analyst at the Center for Financial Research and Analysis.

Included in that account is charges Dell estimates for limited warranties and deferred revenue for extended warranties it sells with its computers. The activity impacting movements within the account are "very opaque," Perler said.

By upgrading its investigation to formal status, the SEC may have reason to believe there are problems with Dell's bookkeeping. The SEC launched its initial probe in September 2005.

A formal order of investigation, which must be approved the SEC's commissioners, gives the agency lawyers subpoena power. Sometimes the SEC does this so it can subpoena a company's vendors or customers or an individual within the company it's investigating.

Analyst David Wong, of A.G. Edwards, which rates Dell a hold, said the PC-provider is dealing with several near-term risks that should give investors pause.

"Visibility into Dell's operations and results has been poor lately," he said in a research note.

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